The Crisis Is Cancelled (For Now)

The summer of crisis, collapse and political disorientation is cancelled. Last night the EU leaders took steps which, though not a complete solution to the crisis, averted its escalation. Crucially Angela Merkel did what she had insisted was impossible: she made major concessions on short-term measures to ease the crisis without achieving the long-term quid-pro-quo German politics had dictated she must demand.

The EU leaders made a series of moves, each separately important, which have averted catastrophy, allowing Europe’s troubles to become “just a crisis” again:

First, the Spanish bank bailout has been changed: money will be injected directly into banks with no corresponding increase in Spain’s national debt. To be clear: the liability is being assumed jointly by countries still healthy enough to inject money into the ESM fund. The Irish bailout will be re-done in this way (though there’s more detail to follow there).

Second, and an important precedent: the Spanish bank bailout money will not create “senior” claims by the bailout fund. Up to now, the countries lending the money had planned to award themselves “seniority” over private sector investors, which could have provoked massive capital flight from the bailed out economies.

Third, they removed the “Troika-discipline” from future bailouts: if Italy and Spain are complying with the rules of the fiscal compact agreed last December, they can get bailout money from the E500bn fund without having to impose tough new austerity conditions.

Finally they agreed to move to a single banking supervisor by 1 January 2013: not the “full banking union” desired by some but a clear and irrevocable step towards it. The single regulator is the only condition secured by Germany for the release of all the other monies and permissions.

What’s missing is the commitment, demanded by Italy, for the EFSF and ESM to intervene in the bond markets – buying the bonds of stricken countries – in a kind of bailout-via-the-market: but it is still permitted and if done it will be led by the European Central Bank, allowing the ECB to use the 500bn fund in a way that fudges fiscal and monetary intervention.

The memorandum begins: “We affirm that it is imperative to break the vicious circle between banks and sovereigns.” And to this extent it does what it says on the tin.

Europe stood on the brink of a Spanish and Italian debt crisis that would have a) required massive austerity in both countries and b) probably been the signal for massive capital flight from Europe. There was real fear that one or more countries would exit the Euro; that Spain and Italy would be forced to default; that the subsequent revaluation of assets would sink several core-country banks; that the technocrats, having failed, would be replaced in short order by ideological politicians, not least a back-from-zombification Silvio Berlusconi.

This is all averted. Provided the Germans buy what Merkel signed up to.

However, having broken the link between bank and sovereign debt crises, these crises still exist. Spain is – as Joe Stiglitz said on Newsnight last night – in a depression. Italy is stagnating. There is still and inter-bank credit crunch across Europe and all three sectors: consumer, banks and governments are still overwhelmed by bad debt.

As the hours ticked towards conclusion I received the latest of several briefings from people who were “talking to the Germans” – ie to senior CDU politicians, bankers, businesspeople etc. The message was “we’re prepared to inflict pain on Europe now – including a recession on ourselves – to secure tough fiscal rules for the next generation. We can sit it out.”

That’s probably what Mrs Merkel went into the meeting thinking. But the rapid shift in the balance of forces in Europe defeated her, once she could no longer use Sarkozy as a human shield.

Instead she has come out of the bruising overnight encounter committed to bailing out southern Europe with German taxpayers’ funds: with no seniority for the debt and no special conditions of austerity such as were imposed on Greece, Portugal and Ireland.

So though its not the end of the crisis, it’s the end of an era – which started with the first Greek bailout and ended in Brussels last night – in which Franco-German policy was to impose internal devaluation measures on the south that caused one Daily Telegraph economist to describe them as “basically fascist”.

Growth is the solution to indebtedness, is the subtext of last night. Growth plus regular, long-term fiscal balancing measures and tough supervision of the banks. This, in its own way, brings Europe into line with America – where President Obama has completed the image of this as a corner-turning week but facing down the challenge to his healthcare law.

That leaves only one major economy committed to austerity first and growth maybe. It’s an economy that could do with a bit of effective banking supervision itself. If the bond markets become convinced Europe is stabilized, they may now look quizzically at this last major economy, mired in a double dip recession and with – on the admission of its industry minister – no real growth strategy. Meanwhile that country’s people – seeing the 17-member Eurozone racing towards a banking union and locked-in fiscal policies.

To put it another way: the battle of Europe is over (for now). The battle of Britain may be about to begin.

** PS – as I say again. This is provided Merkel sticks to the deal. The actual wording of the communiqué is quite clear, if terse.